The IFRIC recently issued for comment a tentative agenda decision on Economic Benefits from Use of a Windfarm, with comments requested by August 16, 2021.

Here’s the fact pattern:

• The Committee received a request about whether, applying paragraph B9(a) of IFRS 16, an electricity retailer (customer) has the right to obtain substantially all the economic benefits from use of a windfarm throughout the term of an agreement with a windfarm generator (supplier). In the fact pattern described in the request:
  • 1. the customer and supplier are registered participants in an electricity market, in which customers and suppliers are unable to enter into contracts directly with each other for the purchase and sale of electricity. Instead, customers and suppliers make such purchases and sales via the market’s electricity grid, the spot price for which is set by the market operator.
  • 2. the customer enters into an agreement with the supplier. The agreement:
    • (a) swaps the spot price per megawatt of electricity the windfarm supplies to the grid during the 20-year term of the agreement for a fixed price per megawatt, and is settled net in cash. In effect, the supplier receives a fixed price per megawatt for the electricity it supplies to the grid during the period of the agreement and the customer settles with the supplier the difference between that fixed price and the spot prices per megawatt for that volume of electricity.
    • (b) transfers to the customer all renewable energy credits that accrue from use of the windfarm.

The criterion of having the right, conveyed under a contract, to obtain substantially all the economic benefits from an identified asset is one of the keys to determining whether a lease exists. The submission that triggered the committee’s discussion set out a few reasons why that might exist here. For instance:

• …the substance of transaction must be analyzed in light of the market structure in which it takes place. The gross pool electricity market prevents participants from contracting directly with each other. They necessarily must go through the gross pool electricity market operator, which in substance acts as their agent… Electricity is fungible, thus the electricity produced by the identified windfarm and the electricity purchased from the gross pool electricity market are indistinguishable. Typically, retailers enter power purchase agreements for a base load of electricity they know they will require. In theory, it is possible that the retailer could purchase less electricity from the gross pool electricity market than the electricity produced by the windfarm identified in the PPA. However, in practice, because the PPA covers the base load expected to be required, the total volume purchased by the retailer from the gross pool electricity market is always more than the volume produced by the identified windfarm. Only in extreme circumstances would the volume purchased be less than that produced by the windfarm. Therefore, the generator sells the volume produced into the gross pool electricity market and the retailer in turn buys the same volume or more from the gross pool electricity market, which is in substance similar to a transaction in the net pool electricity market.

Noting that IFRS 16:B21 describes economic benefits very broadly – “A customer can obtain economic benefits from use of an asset directly or indirectly in many ways, such as by using, holding or sub-leasing the asset”- the submission also noted:

• the retailer has obtained a fixed cost per unit of electricity volume that matches the volume produced by the windfarm. As a result, it has the ability to obtain all of the economic benefits from the sale of that volume of electricity to its clients.
• windfarms are typically only built in locations where a feasibility study demonstrates high certainty over the availability of wind to generate the required electricity. Consequently, typically, there is little variability on wind risk and only as a result of a catastrophic event would a major variance occur.

Despite all that, IFRIC concluded that the criterion isn’t met here, and that the contract therefore doesn’t contain a lease, on the following narrower basis:

• The agreement results in the customer settling with the supplier the difference between the fixed price and the spot prices per megawatt of electricity the windfarm supplies to the grid throughout the 20-year term of the agreement. That agreement, however, gives rise to neither the right nor the obligation for the customer to obtain any of the electricity the windfarm produces and supplies to the grid. Although the customer has the right to obtain the renewable energy credits (which represent a portion of the economic benefits from use of the windfarm), the customer does not have the right to obtain substantially all the economic benefits from use of the windfarm because it has no right to obtain any of the electricity the windfarm produces throughout the period of the agreement.

That is, IFRIC went with the view that it’s not “appropriate to draw a conclusion based an ‘in substance’ analysis which ignores the market structure and consequential contractual rights and obligations.” Although the conclusion is clear, and no doubt technically correct, I don’t think it follows that the alternate view was massively ill-conceived. Rather, it perhaps illustrates the eternal difficulty in determining the practical limits on appropriately applying substance over form…

The opinions expressed are solely those of the author.